Your firm successfully issued new debt last year, but the debt carries covenants

Question

Your firm successfully issued new debt last year, but the debt carries covenants. Specifically, you can only pay dividends out of earnings made after the debt issue and you must maintain a minimum quick (acid-test) ratio (Current Assets - Inventory) / Current Liabilities of 1.1. Your net income this year was $70.1 million. Your cash is $10.1 million, your receivables are $7.8 million, and your inventory is $4.6 million. You have current liabilities of $19.2 million. What is the maximum dividend you could pay (in cash and in stock) this year and still comply with your covenants? The maximum dividend would be $ 65.0 million. (Round to one decimal place.)

Explanation / Answer

Total Net Income = $70.1 Mn

Total current assets =$10.1 +$7.8 + $4.6 = $22.5

Current liabilities =19.2 Mn

Curent Acid ratio = (22.5 -4.6)/19.2 = 3.3/19.2 =17.9/19.2=.93

As the current ratio is already below 1.1 no dividend would be paid out

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